Tag Archives: Greek crisis

The shock referendum announcement by Alexis Tsipras over the Troika’s austerity demands has radically increased the chance that Greece will fall out of the eurozone.

I am surprised that the markets, and indeed the Greek people themselves, did not give more credence to this outcome over the last few weeks. The received wisdom of most market pundits is that an 11th hour agreement would be reached.

Meanwhile, Greeks have been pulling money out their banks, but at a very leisurely pace. To me, this nonchalance appears bizarre. The chart below shows Greek bank private-sector deposits falling from 160 billion euro prior to Syriza’s election victory to around 130 billion euro at end May. The chart is made to look more spectacular by having the y-axis commence at 100 billion euro.

Even if last week you had only assigned a 5% probability to a return to the drachma, such an outcome would result in a 30-50% decline in the value of your savings when denominated in euro. Risk equals probability times effect. The probability might have been assessed—wrongly as it turns out—as small, but the impact should have been deemed as large. The prudent man or woman would have parked their money abroad until a deal was sealed and then repatriated the money once confidence was restored. And for small accounts that couldn’t justify the hassle and fees of an inter-country transfer, you could always stash cash under the bed. Yet relatively few have followed such a simple risk control strategy (Chart from Bloomberghere).

At this point, it appears improbable that the banks will open on Monday, and the Greek authorities will have to introduce capital controls and bank deposit withdrawal limits. If this is indeed the case, the likelihood of avoiding a return to the drachma looks remote.

Very soon the blame game will begin. However, from my perspective there is a certain inevitability about the outcome, which rests on long-term economic and political factors that are rarely raised by most commentators. After a political tour to Greece two years ago, I blogged about these issues here, here and here.

Front and centre of the factors driving Greece toward its current predicament is the country’s terrible demographics. Let’s look at its current and projected old-age dependency rate, which I took from Eurostat. Currently, the ratio of the elderly (65+) to working age (15-64) is 1:3. However, this ratio is rapidly moving toward 1:2 (click for larger image).

Not surprisingly, such demographics are putting a huge burden on the state with respect to pensions. Even the right-of-centre Wall Street Journal goes beyond the stereotype of greedy Greeks in recognising this fact (source: here). So while the aggregate Greek pension burden is very high in a European context when compared with GDP, it is not so high when we put pension spending on a per person basis.

With demographics like this, the only way a country can maintain living standards is through securing high productivity growth. And to do that, in a global economy, a country needs a comparative advantage in industries that exhibit high productivity growth.

Unfortunately, since entering the euro at what proved to be the wrong rate, Greek growth has been concentrated on just a few industries such as tourism, real estate, shipping services and infrastructure projects benefitting from EU regional development funding. Many of these industries got savaged in the wake of 2008/09 financial crisis, and those that have remained reasonably robust, such as tourism, are not great engines of productivity growth.

As Japan amply demonstrates, when a country enters a steep demographic transition, it is very difficult to secure high rates of economic growth. But that doesn’t mean that you can’t maintain full employment, social cohesion and well-being. Japan has partially done this through accepting declines in real wages and a depreciation of its currency. Indeed, the Japanese middle class tourist, once king of Bloomingdales and Harrods in the 1980s, is now relegated to factory outlets.

For the IMF, Greece has been pushed toward reformimg its soft infrastructure: land registry, tax collection, business licensing system, closed shops and so on and so forth. These are all noble causes—and in the course of time should bring some productivity improvements. But the IMF‘s second critical goal, internal devaluation, has proved a disaster. Adjusting wages and prices downwards without producing an economic slump is an almost impossible task. Moreover, the key demographic segment that is critical to future productivity gains—highly educated young adults—have reacted to austerity by flocking to the UK and Germany in droves. The Guardian reported on this depressing brain-drain in January this year (here)

If you are struggling with adverse demographics and poor competitiveness, the last thing a country needs is for its actual economic output to be substantially below its potential output. But this is what you get if you implement a vicious policy of austerity within the context of a lack of effective demand and a fixed exchange rate. Far better is to adjust prices through maintaining a flexible exchange rate and allowing a modicum of inflation. And the only way for this to occur is for Greece to leave the euro and return to a freely floating drachma.

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In my last post, I outlined the IMF’s abysmal track record in charting Greece’s GDP growth path. The IMF’s initial Stand-By Arrangement (SBA) programme was expected to produce a single-digit dip in GDP followed by a rapid recovering. In reality, GDP has crashed by over 20% and we see no sign yet of any expansion.

In the Fund’s May 2013 “Greece: Ex Post Evaluation” publication, the IMF admitted some failings in its growth forecasting and its assessment of what would drive the recovery:

Competitiveness improved somewhat on the back of falling wages, but structural reforms stalled and productivity gains proved elusive.

Note that economic recoveries from recessions usually have two components: 1) the gradual removal of the gap between potential output and actual output as idle capital and labour is gradually put back to work, and 2) a pick up from long-term structural productivity gains as new technology becomes available. The former can be thought of as a short-term cyclical component of growth and the latter as a long-term structural component of growth.

The IMF’s biggest forecasting mistake was with respect to Greece’s true potential GDP. In short, as we headed into the Great Recession, Greece was probably in the situation of having actual GDP far in excess of potential GDP. Accordingly, the IMF expected the economy to rebound to an equilibrium that just did not exist. How could this be? Continue reading →

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Back in February 2012, I wrote a post entitled “Greece as the Canary in the Coal Mine for Collapse?” in which I wondered whether the harshness of the Greek recession (perhaps better described as a ‘depression’) could unpick the socio-political order so as to push the country into collapse. After a two-week political tour of the country that stretched from the outlying islands to Athens, and took in both the elites and the underclass, the quick answer to my question has to be ‘no’.

It is easy to find examples of poverty and desperation: the photo I took below is of a stray cat sleeping on a homeless woman in the square of Athens’ central cathedral. The blog Zerohedge has assembled similar such photos to create a narrative of a country sinking into a state of impoverishment and despair. But you can play this game in any major city of the industrialised west: London certainly has a similar army of the down-and-out and destitute.

Yet what I saw in Greece was a society showing remarkable resilience. Take George, a bartender on the idyllic island of Samos. George is a live example of the IMF’s prescribed policy of ‘internal devaluation’. By ‘internal devaluation’, the IMF means the domestic resetting of wages and prices to restore the competitiveness of the Greek economy. Unfortunately, and as the IMF admits, most the adjustment has fallen to wages and little to prices. Continue reading →